Making sense of the chaos in the markets

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Max King – global strategist, Investec Asset Management discusses sovereign defaults.

HILTON TARRANT: Max King is global strategist at Investec Asset Management in London and joins us now. Max, markets globally pretty spooked at the moment. Over the past 24 to 36 hours a lot of talk suddenly around the risk surrounding a sovereign debt crisis in a number of countries and regions. What essentially is going on?

MAX KING: Well, I have to say that other people may be surprised but we are not. A lot of people were pretty optimistic about the first half, thinking that the problems would be postponed. We've been pretty cautious about the first half, thinking it'll be dull, but thinking that if the clouds started to lift we would see a much better second half. So we had low expectations, and the fact that the market's been .... comes as less of a surprise to us than to others. The reasons why the markets have been weaker are what we've been worried about - the monster budget deficits overhanging developed-world countries, not just in Europe but the UK, Japan and the US. And we just think that is like a sword of Damocles which prevents investors from digesting the very good news on corporate earnings and cash flow, and that's causing investors to be nervous that there's going to be some blow-up. Of course, there is some blow-up in the euro; we all know that the euro system is completely unsustainable and it's not going to last. The idea that that's going to ultimately dissolve into chaos I think is not right. I think ultimately the ... of the euro is going to be good news and it looks as though it might well happen rather sooner than the time table we had, which is about three years from now.

HILTON TARRANT: Max, lots being made of countries like Spain, like Greece, like Portugal, which are sitting with pretty substantial deficits, pretty substantial levels of unemployment, needing to borrow zero hedge, managing to coin a term "stupids" recently including Spain, Turkey, the UK, Portugal, Italy and Dubai in that grouping. How real is this risk?

MAX KING: Well, there's a difference between Greece on the one hand and Spain on the other hand. Greece really, it's fiscal ... has been pretty responsible for a long period of time; it's taken the free ride of the euro and spent it. That's why it's in trouble. That contagion has spilt ... Spain, because the economy will go into ... construction, the economy has fallen very dramatically, there's large deficit and there's high unemployment. Spain has basically done a reasonably good job of sorting out its affairs in the last ten years, first in the EU and then in the Eurozone. But likewise Italy too. One mustn't take away from the fact that actually a lot of these countries are immeasurably better and stronger countries than they were 10, 15, 20 years ago. But it's not enough, and the reason is that Germany keeps driving the Eurozone forward. Germany is really a bit like China was until last year - driving for massive trade surpluses, driving the competitors into export industries and suppressing consumption. And really what Germany has been doing is embarked on this beggar-my-neighbour .... policy ... members of the Eurozone and they can't catch up. So it's not just that some of the weaker members of the euro are falling behind, so that actually Germany is forcing a pace which is unreasonable to expect them to keep up with.

HILTON TARRANT: We are seeing some pretty interesting timing from the central banka, the Bank of England and the European Central Bank both signalling yesterday that they are ending or planning to end parts of their stimulus programmes. In hindsight, was yesterday perhaps the best time to have announced this?

MAX KING: Well, it's not just yesterday. This has been on the cards or been pretty formally announced on a regular basis the last few months. And actually, it's a very sensible policy indeed. What the central banks are saying is: We did quantitative easing to give you governments time to sort out your fiscal affairs. Instead, you took it as a free ride and did nothing. So now we are telling you the ball's in your court. If you want to keep interest rates low and you want more quantitative easing, you've got to do something sustainable and credible about the fiscal deficits. So there's an ultimatum from central banks to governments. Now if governments, particularly the UK, take up the baton and cut spending, then we believe that the Bank of England, for example, will undertake to keep interest rates low and may well bring back some corporate easing. If not, then the Bank of England is going to be unhelpful. Ultimately this point had to come otherwise Britain would have devolved into a sort of Zimbabwe, printing out ten-, hundred-, trillion-dollar notes before the politicians actually realise there's a problem.

HILTON TARRANT: Max, with the recent moves in the markets, what has this meant for emerging markets specifically?

MAX KING: Well, the interesting thing about yesterday in particular was everything went down together - equity markets went down, the dollar went up, gold came off, oil came off. To our way of thinking that probably tells us that the mini-down-cycle is over, that's a sort of universal sell opportunity this side of the bottom. So we would actually now expect the dollar to come up a bit, gold to rally, the oil price to rally and equity markets to rally. When it all goes up emerging markets tend to come down. There's a lot of negative view about emerging markets at the present, people saying if the dollar goes up, emerging markets will fall. Probably too much money went into them last year. It's all fair comment. But in our view that the structural story of emerging markets is intact and there isn't excessive valuation, and the earnings growth is very good and companies are good. So we still see for this year and the future years steady emerging market outperformance, both in the equities and in the bond markets. So we don't see it as a roaring relative bull market as we saw last year, where you made a fortune in emerging markets and did quite well in developed markets, but we do see steady outperformance over the long term.

HILTON TARRANT: Max, just looking ahead to the G7 meeting, our finance ministers - are we likely to see anything concrete from that, or is it basically just a bunch of hot air?

MAX KING: It's basically just a bunch of hot air with a few photo opportunities. I think actually governments are going to stop talking to each other and start looking to their own back yards to see what they need to do themselves. I think Obama's decision last week, saying that he wasn't going to the next summit, because frankly he's got better things to do with his time, was a very welcome sign that Obama's at last seeing the light and addressing the real issues, rather than parading on a global stage in front of the cameras.

HILTON TARRANT: Max King, joining us from London, is global strategist at Investec Asset Management.